More Markets

1. More Markets

2. Relative Scarcity • How scarce is one good or service compared to all other goods and services? • Relative scarcity is the relationship between supply and demand. • Price is the measurement of relative scarcity. • What determines the price of a work of art, an antique, an old stamp or coin?

3. What is an equilibrium price? • The measure of relative scarcity. • Relative scarcity is the relation between supply and demand. • How scarce is one product compared to all others? • The unit of measurement is the price in the domestic currency. (e.g. $43.37)

4. Relative prices: why? Diamond $50,000 Insulin $5

5. Price: indicator of relative scarcity (Units on the Scarcometer)

6. Order these products in terms of relative scarcity • yacht • candy bar • nice dinner for two in San Francisco • mini truck • laptop computer

7. Order these products in terms of relative scarcity 1 yacht 5 candy bar 4 nice dinner for two in San Francisco 2 mini truck 3 laptop computer

8. Equilibrium Price The measure of Relative Scarcity • Feet and inches measure distance. • Pounds and ounces measure weight. • Degrees Fahrenheit measure heat. • Cups and pints and quarts measure volume. • Dollars and cents measure relative scarcity in the U.S.

9. Relative Scarcity • Not the same as rare • Rare tropical disease is not scarce (no demand). • Gold is more scarce than water even though water is essential for life. (Supply of water is greater than the supply of gold.) • Some collectors’ items are more scarce than others depending upon supply and demand. Their prices go up or down depending upon changes in supply and demand.

10. Relative Scarcity • Relative scarcity is not a subjective evaluation of worth or value or social contribution even though some of those considerations are included in the demand function. • To the extent that some can manipulate supply or demand, they may influence relative scarcity and price but price remains the measurement of relative scarcity. • OPEC • Advertising • In a market with CIIP, price is the accurate measure of the relative scarcity of a good or service.

11. Relative Scarcity • The relationship between supply and demand. • Measured by the equilibrium price • Not the same as rare • Not a matter of supply alone • Not fair or unfair

12. The Law of Supply • Once all other factors (WAGTIPS) have been considered, the quantity supplied of a good or service varies directly with the price of the good or service; price goes up, quantity supplied goes up. • The influence of price on quantity supplied is a short run phenomenon and assumes no change in WAGTIPS. • The Principle of Exchange – if the price received by the supplier is greater than all production costs, the supplier will supply the product. • Price is an incentive to suppliers

13. Diminishing Marginal Returns • Given some fixed inputs, additions of the variable inputs will yield lower additional products. • Since each of the variable inputs are paid the same, marginal costs increase as production increases. • Marginal resource costs rise as production increases. • Therefore, suppliers must receive a higher price to supply a greater quantity, assuming no change in WAGTIPS.

14. Price Elasticity of Supply • Measures the strength of sellers’ reactions to a price change. • How much will quantity supplied change as a result of a price change? • Depends upon suppliers’ ability to increase or decrease production in the short run. • How flexible are resources used in production?

15. The Law of Demand • Once all other factors have been considered, the quantity demanded of a good or service varies inversely with the price of the good or service. • Price rises, quantity demanded falls; price falls, quantity demanded rises. • The Principle of Exchange – if the price asked is greater than the expected benefit, the demander will not buy the product; if the price asked is less than the expected benefit, the demander will buy the product. Price is a disincentive to buyers. • Higher prices send buyers in search of substitutes.

16. Diminishing Marginal Utility and Demand • Utility is the benefit that consumers get from consuming goods and services • As consumers consume more of a product, the additional utility from additional units of the product decreases – the law of diminishing marginal utility • To entice buyers to buy more as their marginal utility falls, price must also fall, making the price lower than the expected benefit. (The principle of exchange)

17. Price Elasticity of Demand • Measures the strength of buyers’ reactions to a price change. • How much will quantity demanded change as a result of a price change? • Depends upon • availability of substitutes • Percentage of total expenditures • time

18. Allocative Efficiency • At the equilibrium price, the marginal utility of consuming the product is equal to the marginal resource cost of producing the product. • From society’s perspective, this is the optimal resource allocation to this particular activity • Attempts to change the price of a product through regulation will distort incentives and cause resource misallocation.

19. A Price Above Equilibrium • If a price is above equilibrium, a surplus exists. (The quantity supplied is greater than the quantity demanded at the higher price.) • With no barriers, price will begin to fall towards equilibrium • As price falls, quantity supplied will decrease and quantity demanded will increase. • Eventually, price will fall to the equilibrium where quantity supplied is equal to quantity demanded, which is the quantity exchanged.

20. A Price Below Equilibrium • If a price is below equilibrium, a shortage exists. (The quantity demanded is greater than the quantity supplied at the lower price.) • With no barriers, price will begin to rise towards equilibrium • As price rises, quantity demanded will decrease and quantity supplied will increase. • Eventually, price will rise to the equilibrium where quantity demanded is equal to quantity supplied, which is the quantity exchanged.

21. Surplus and Shortage • Surplus: at a price above equilibrium, quantity supplied is greater than quantity demanded. • Shortage: at a price below equilibrium, quantity demanded is greater than quantity supplied. • Surpluses and shortages are always in reference to specific non-equilibrium prices. • They will be automatically eliminated by price changes if there are no barriers to price movements.

22. Price Floors and Ceilings • A legislated price • A price floor is a minimum price. Prices can be higher, but not lower than a floor. (Minimum wage) If the floor is above the equilibrium, a surplus is created. • A price ceiling is a maximum price. Prices can be lower, but not higher than a ceiling. (Rent controls) If the ceiling is below the equilibrium, a shortage is created.

23. Price Floors and Price Ceilings Price cannot fall below a floor Price cannot rise above a ceiling

24. A Price Ceiling - shortage • Who gains? • Politicians • Those who get the goods and services • Those who police the ceiling • Who loses? • Those who supply the good or service • Those who can’t get the good or service • Taxpayers

25. A Price Floor - surplus • Who gains? • Politicians • Those who supply the goods and services • Those who police the floor • Those who store the surplus • Who loses? • Those who demand the good or service • Taxpayers

26. Price Controls - The Message • Price controls distort market incentives • They can not change the relative scarcity of the product • They cause over allocation or under allocation of resources • They cause arbitrary distributive effects • But they are great politics!

27. Markets during Disasters • What happens to markets for wood, tools, and even water during a disaster? • Can’t get products in; supply decreases. • More people want these products. Demand increases. • Product is relatively more scarce.

28. Markets during Disasters • What happens to markets for wood, tools, and even water during a disaster? • What incentive would cause suppliers to supply more of the product? • A price ceiling prevents the price from rising. • The shortage worsens.

29. Disasters usually cause shortagesPrice ceilings make the shortages worse. Government price controls can’t change relative scarcity, but they do distort incentives

30. The Market in Disasters • Considering the market, what happens to products like wood, tools, and even water during a disaster? • Trucks can’t bring products in, therefore supply is decreased • More people need these products than normal- Demand increases. • So why do people cry price gouging?

31. Price Gouging??? • If the government felt sorry for these people and imposed a price floor on certain products, we, as economists, know that there will be a shortage. • Other people feel that the prices are “made high” to take advantage of the affected people- simply not true.

32. PRICE CONTROLS DISTORT MARKET INCENTIVES and CAUSE RESOURCE MISALLOCATION

33. Main Points • Relative scarcity for a particular product is the relationship between supply and demand. • With CIIP, supply and demand determines the relative scarcity of a product, which is accurately measured by the price of the product. • The Law of Supply states that price and quantity move in the same direction. This assumes no change in WAGTIPS. • Price elasticity of supply measures the strength of suppliers’ response to price changes.

34. Main Points • The Law of Demand states the price and quantity demanded move in the opposite direction. This assumes no change in TIPSE. • Price elasticity of demand measures the strength of buyers’ reactions to price changes.

35. Main Points • Supply represents the marginal opportunity cost of producing different quantities of a product. • Demand represents the marginal utility of consuming different quantities of a product. • Allocative efficiency occurs at the equilibrium where the marginal opportunity cost of producing a quantity is just equal to the marginal utility of consuming that quantity.

36. Main Points • A surplus exists at a price above the equilibrium where the quantity supplied is greater than the quantity demanded. • A shortage occurs at a price below the equilibrium where the quantity demanded is greater than the quantity supplied. • With no price floor, a surplus will correct itself as the price falls. • With no price ceiling, a shortage will correct itself as the price rises.